By Philip Pilkington, a journalist and writer living in Dublin, Ireland

The engine that drives enterprise is not thrift, but profit – John Maynard Keynes

Profits are without doubt the key driving force in a capitalist economy. No respectable entrepreneur would try to sell goods or services were they not to make some sort of profit out of it. And yet profits are spoken of surprisingly little in mainstream neoclassical economics. For the neoclassicals there is, in fact, a deafening silence surrounding the role that profits play in the functioning of our economies; economies that are, of course, founded on the profit motive.

For example, if we turn to a fairly standard mainstream textbook – in this case Samuelson and Nordhaus’ ‘Economics: Fifteenth Edition’ – we find just how little neoclassical economics concerns itself with profits (some will say that Samuelson is a Keynesian, indeed he would probably have said so himself, but Samuelson is not really a Keynesian, his ‘neoclassical synthesis’ was just a grafting of a vulgarised Keynes onto the neoclassical edifice). This 800-odd page book devotes all of three pages to the topic. And even in this short space the authors are vague and fuzzy. We are told that profits come from ‘a hodgepodge of different elements’; that they are earned as a ‘reward for bearing risk’ and that occasionally they take the shape of ‘monopoly returns’. At no point do the authors even dare to suggest where profits come from.

This must appear to anyone with even a cursory interest in how our economies work as a rather unusual evasion. And it should. Usually when people are evasive on such important issues it is because – whether they know it or not – they are hiding something. In this case the authors are – again, whether they know it or not – hiding something extremely important; namely: the origin, source and function of profits in a capitalist economy.

There is a Microeconomist Inside All Our Heads: He Must Be Destroyed

The problem when it comes to thinking about profits is that, as with most economic concepts, we all come to the table with preconceived ideas that we have derived from our personal experiences. We have experienced the generation and acquisition of profits in our everyday lives and we seek to carry this over into how we conceptualise the world.

But our perceptions are limited to only the crudest of microeconomic phenomena. We might recall that fair time when we set up a lemonade stand as a child. We bought the lemons and the sugar, mixed them together and sold them on the street outside. Kind passersby and neighbours then bought the bitter liquid and politely sipped it through twisted lips. Our profits – if indeed we made any – came from selling our lemonade for more money than we bought the ingredients. Add to that a pinch of labour and a dash of entrepreneurial spirit and you’ve got a perfect recipe for profits.

So this is how we instinctually think about profits. Indeed, if we read Samuelson, Nordhaus and many other mainstream economists we find that rather than actually seeking to understand the world around them, they too are trapped in the sweet memories of their childhoods.

The microeconomic ideas of the mainstream economists give us little insight into how profit works in a modern economy or what role it plays. Neoclassical theory, as discussed above, tries to push profits to the margins. This is because to truly recognise the function of profits in a capitalist economy would destroy many aspects of neoclassical theory itself.

Neoclassical theory is an ideology of truck and barter – a trumpet sounded for commerce of all sorts. It does not ask any real questions about origins. Instead neoclassicals focus on the superficial. They ask questions about the child and his lemonade stand, rather than inquiring about where the child’s profits came from given the broader economy. Their theories are heavenly and idealised structures – built on foundations of air.

In order to stay firmly grounded we need to explore just where profits come from given the broader economy and through what processes they arise. When we discover the true origins we can then ask all sorts of questions; questions about monopolies, about financial instability and about the pristine, efficient markets of the neoclassicals – and why, in the long-run, the latter can never really generate profits in the macroeconomy.

These questions will be put on hold for now and broached in later pieces. What we must first come to understand is that money doesn’t grow on trees – and neither do profits. They have a specific and important place in how a capitalist economy functions. It is to this that we now turn.

A Capitalist, A Bank, Ten Workers, Two Presidents and a Giant Loaf of Bread

Like many ideas in macroeconomics the theory of profits is remarkably complex – or, rather, it becomes so very quickly when looked at in any detail. And yet we can essentially boil it down to a fairytale; a fairytale about a capitalist, a bank, ten workers, two presidents and a giant loaf of bread.

We imagine an island. On this island we find a capitalist (or an ‘entrepreneur’ to use more politically correct language), a bank, ten workers and a government. Five of the workers are bakers and five of them are builders. We assume that the capitalist does not consume anything and that there are no input costs apart from the cost of labour. In addition to this capital goods (machines etc.) do not depreciate in value (wear down etc.). Finally, the workers do not save. In other words: they consume all that they earn.

(This seems silly but we can include these variables in more complex models, some of which will be dealt with in more condensed form later. For now let us just say that all this occurs because the island is magic and a wizard created it…).

The capitalist must pay the workers at least $1 a day as the government has a minimum wage law in place. So, the capitalist hires five workers (the builders) to build a bread factory – spending $5. He then hires the other five workers (bakers) to make bread in the factory – spending an additional $5. All of this money is raised from the local bank which charges him a rate of $1 interest a day. The capitalist ends up with a giant loaf of bread which he sells to the workers for all their wages – the bread thus sells for $10 and each worker gets a 10% share.

We must stop here for a moment to highlight an important fact. Note that the overall amount of spending power in the economy – that is, the workers’ aggregate wages – determines the price of the bread. The bread is divided into ten because there are ten workers, but it is the amount they are paid that sets the price of the bread. More on this in a moment, for now we get back to our fairytale.

At this point, the capitalist has a brand new bread factory and his $10 back which, after paying making his interest payment for the day, totals $9. He then hires his five bakers once more at $1 each and bakes another giant loaf. If this loaf were allowed to go directly to market a deflation would result and he would only get $5 for the loaf – with each worker getting a 20% share. This is because the same capitalist, since he already has his factory built, no longer needs to hire the five builders and so only the five bakers are employed. If there were no other actors in the economy these builders would remain unemployed and the aforementioned deflation would result. However, Roosevelt II has just been elected and, being the clever president that he is, he deficit spends to hire the builders to build a road in front of the bread factory – paying the minimum rate of $1 per worker.

At the end of the working day, the builders once more join the bakers at the factory door and, since everyone has received their wages, the bread sells at its previous rate – the capitalist gets $10 (after interest payments he has $9), the workers all get a 10% share of the giant loaf and there is no deflation. This time, however, the capitalist ends up with a tangible profit because the government has taken over the task of investment.

Once again, we must stop for a moment to examine what is going on here. It has now become clear where these profits are coming from: investment. Previously the capitalist was investing in his bread factory and this was generating wages that he would then take in as income. But now that his factory is built he need not spend any more money on investment so the government steps in and invests instead and this money returns to the capitalist as a tangible gain.

The key point here is that investment creates profit. We shall deal with this in more detail later on.

Everything on the magical wizard island is going well. The workers are fed, they’re voting in the right man who is keeping them employed and the capitalist is making healthy profits. But then Nixon II seizes power in a coup and, having to face an election to solidify his reign constitutionally, he ramps up deficit spending. The builders are taken off working on the roads and are drafted into the military to ensure discipline and loyalty. To quell any discontent they have their wages increased from $1 to $2. When all the workers turn up at the factory gates, the builders-turned-soldiers have more purchasing power than the bakers and they get a bigger share of the loaf – the bakers now only get a 6.66% share while the soldiers get a 13.3% share.

The capitalist, however, ends up with $15 for the loaf as there has been a general inflation due to the increase in the builder-cum-soldiers’ wages. He is delighted to have pocketed $10 of profit from an outlay of only $5 – he has effectively doubled his profit. Where it was only $5 under Roosevelt II, it is now $10 under Nixon II.

However, his joy proves short-lived. The bakers turn up the next day demanding wage-increases to match the soldiers so that they can have a fair share of the giant loaf. If the capitalist doesn’t comply the workers will go on strike or seek work from the government. The capitalist thus has to meet the workers demands and pay them $2 per head. So, he loses his extra profit, they consume as they did before and there is a 100% increase in prices and wages. The capitalist says that he’s going to take away his campaign contributions to Nixon II if he doesn’t curb the inflation, so Nixon II hires an economic advisor.

Before we move on we should take note of an important fact about deficit spending. In our simple model deficit spending was not necessarily a bad thing. Had Roosevelt II not undertaken deficit spending and road construction, half the workers would have been left unemployed and the economy would have suffered a general deflation, which would in turn have thrown business into disarray as the capitalist would have only broken even and been unable to meet his interest payments. The problems arose when Nixon II tried to use deficits as a political rather than an economic tool to please his would-be supporters. In doing so he continued to spend beyond the point of full employment and caused a general inflation (not to mention his wasting resources on a stagnant and useless military-industrial complex).

Although this is a crude model, the lessons transfer rather well to the real world. As a rule of thumb, deficit spending by a government is profit and job enhancing provided that the economy is not already operating at full employment – indeed, it is somewhat necessary. Beyond that point, however, a general inflation might occur with all the negative consequences that arise there from.
Now, let us turn to a slightly more realistic model of profits than the current simplified case. This is the ‘general case’ Kalecki model.

Kalecki’s General Theory of Profits – The Wonky Bit

When looked at closely what we have outlined above must come across as rather strange. The profits that the capitalist receives come from investment. Since these profits are then deployed to finance new investment – or, at the very least, are taken into consideration when taking on new financial obligations to fund new investment – we arrive at a strange loop, a sort of ‘snake eating its own tail’. As Kalecki himself put it in his ‘Studies in the Theory of the Business Cycle’ (p. 46):
“It may sound paradoxical, but according to the above, investment is financed by itself.”

So, when the capitalist himself funds this investment the profits he receives are merely his own funds washing through the system and coming back to him. Of course, he receives his capital assets (in the above example his ‘bread factory’) as compensation for his entrepreneurial efforts. But although these new real productive assets are created through the profit cycle, no new financial assets are created. That only occurs when the government steps in with its budget deficit or some other exogenous force enters our island economy.

The above model is perhaps one of the most powerful and the most pertinent for thinking about the sources of profit. However, it is a little too simplified. It makes assumptions that simply cannot be held up in the real world. It claims that workers do not save and capitalists do not consume. Both these assumptions are undoubtedly false. In order to rectify this we need to move from this simplified model, to Kalecki’s general model. (I take what follows from Professor Bill Mitchell’s excellent blog on the topic, ‘Why Budget Deficits Drive Private Profit’ which goes into this topic in greater detail than I do here).

Phew! Now that we have a grasp on that we can move to summarise our findings and try to draw some conclusions.

What Determines Profit?

Profits are determined, to a large, extent by expectations of future gains. That may seem unusual but consider what has been laid out above. Profits, as we know, come from investment and most investment comes from the private sector. Thus, capitalists will be more inclined to invest if they think they can reap future gains. Profits are, in this sense, something of a self-fulfilling prophecy.
Most importantly, as Keynes always pointed out, there is an element of fundamental uncertainty here. Investment is heavily reliant on capitalists’ perceptions of future gains. If the capitalist does not see a market for his products – as happens when spending power (aggregate demand) is too low in the economy – he/she will be reluctant to invest. This, in essence, is how a lack of spending power might drag an economy in a depression or protracted recession. (It is also, of course, precisely what is happening in many countries around the world today).

Consider our original example. When the capitalist laid off his five builders after they had completed his bread factory they lost all their spending power. If they had continued to go unemployed the capitalist would have taken large losses, as he would have only had five rather than ten workers to sell his bread to. He would, in short, have incurred a rather substantial loss. If this had occurred we might predict that the capitalist would have gone bankrupt as his capital was slowly drained away through interest payments and so would not have engaged in future investment. Profits in the total economy of the magical wizard island would have fallen to zero and unemployment would have risen to 100% as the bread factory was taken over by the bank. Every resource on the island would have lain idle.

However, as we recall, the government stepped in and, by running deficits by spending without collecting taxes, hired the five builders so that the level of profitability remained constant. We can then predict that the capitalist would have gone on to further investment. He might have opened a jam factory and employed immigrants. As investment expand so too do profits – and with them, employment and living-standards.

Now, I can already hear the inevitable Austrian chime in. “Arg! You lying Keynesian totalitarian scum! The government didn’t need to invest to employ those five workers; another capitalist could have done so. You’re just a crypto-communist who wants the government to control our lives and tell us what to do! You hate freedom and liberty, ahhh! <3 Ayn Rand 4eva!”.

Our Austrian friend would, of course, be quite correct. The government would not have been required to step in had another capitalist migrated to our island and opened a new industry. And the government would never need to step in were this process to continue ad infinitum. The argument against this – although I don’t want to get too far into it – is twofold.

First of all, Austrians who make this argument are utopians. They tend to view the world in terms of how they imagine it could be, rather than as it is. The fact is that capitalist economies are inherently unstable and unemployment and deflation are always lurking around the corner. Capitalists don’t generally step in to fill in the gap. In fact – bipolar creatures that they are – they tend to run at the first signs of trouble and cause crises (Keynesian uncertainty again). The 19th century, when government intervention was limited, was a time of great instability and myriad financial crises. We have, thankfully, left this world behind us and, to be frank, we would not be able to return to it even if we wanted to.

Secondly and tied to this, is the fact that modern capitalist economies do operate with a fairly large government sector (not quite as large as in our simplified example, but close enough). Austrians will blame this on ‘evil’ people and ‘bad’ elements in society and claim that were these dastardly fiends not listened to, we’d all live in a pure capitalist utopia. Such a view of history is nothing short of paranoid – indeed, it’s a close approximation to how the Stalinists used to rewrite events to show that any bumps on the way to Communist utopia were due to ‘counter-revolutionaries’ and ‘subversives’. Far from a liberating view of the world, such utopian discourses are quasi-religious in their make-up. Were they ever taken seriously they would probably put society on a short road to totalitarian tyranny, as paranoid utopian politicians blamed every instance where the world refused to conform to their idealised view of it as being the result of a subversive Keynesian plot.

Anyway, back to our discussion. Aggregate demand can also come from other sectors. If we look at the Kalecki equation above we see that current account surpluses would also lead to aggregate demand; workers could be employed in the exports sector. This is an important point. But from the standpoint of policy, governments have limited control over how much a country exports and how much it imports. Governments can certainly influence this – through trade tariffs, exchange rate manipulation etc. – but they have no direct control over the external sector. They do, of course, have direct control over their budgets and this is why we emphasise this aspect.

(MMT aficionados will recognise the sectoral balances model of aggregate demand – which I dealt with in this discussion. Indeed, this is where the sectoral balances approach ‘plug into’ the Kaleckian profits approach. While the sectoral balances approach shows how spending in the economy is distributed, the profits approach demonstrates the ‘engine’ through which this is applied to economic development).

We will ignore capitalists’ consumption – that is: the amount that capitalists spend on goods and services because it is rather uninteresting. But note should taken regarding workers’ savings.
Saving by workers affects aggregate demand adversely. When a worker saves money he or she is not spending it and this discourages capitalists from investing. This is contrary to mainstream theory which, being unable to understand the sources of profits, assumes that workers’ savings lead to investment. Mainstream economists believe, erroneously, that capitalists borrow out of a pool of workers’ savings (Bill Mitchell deals with the ‘crowding out’ theory in the following blog). This is simply not the case in a modern economy and our discussion leads us to the exact opposite conclusions: all else being equal, workers’ savings lead to less potential for profitability. Of course, if workers go into debt (i.e. ‘negative savings’) they will certainly spur aggregate demand and lead to an investment boom. The 1990s and early 2000s ‘goldilocks’ economy – as discussed in my article linked above – shows how such a process might come about and its consequences.

Conclusion

As we can see, profits actually come from some fairly unusual sources. Government spending up to the point of full employment actually increases profits, while workers’ savings diminishes them. This ties into the MMT argument that government should offset workers’ desired savings. As we can clearly see from the contemporary situation, this happens in an almost automatic manner; as the private sector saves and pays down debt in the current uncertain environment, the government goes into deficit in order to float profitability.

We should also note that capitalist economies are not perpetual motion machines. Many people seem to have a vague inclination that capitalist economies are somehow ‘self-generating’ and, for example, that government spending or private debt-financing are exogenous or external factors. This is clearly not the case. Money enters the economy through either government spending or private sector indebtedness. These then wash through the economy and eventually turn up as profits. These facts need to be front and centre when public policy is considered.

Now that we understand the basic dynamics of profit in a capitalist economy we can explore a number of different issues; including: monopoly profits and financial profits and the role of profits in a financial crisis. With our basic understanding we will be able to investigate these in more detail in later pieces.

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153 comments

And yet profits are spoken of surprisingly little in mainstream neoclassical economics. For the neoclassicals there is, in fact, a deafening silence surrounding the role that profits play in the functioning of our economies; economies that are, of course, founded on the profit motive.

Evidently statism MMT-style also doesn’t speak of them (meaning takes their existence for granted), and for the same reason – because these “profits” are actually a sham.

Even taking capitalism as normative, “profit” should have withered away by now as all sectors matured. Capitalism’s own textbooks say so.

What really happened was that corporatism enabled oligopolies to calcify in all sectors, actual competition (which would have driven the profit rate to the absolute minimum) was suppressed, and the neoliberal strategy was launched. Government engaged in massive intervention every step of the way to facilitate this suppression of real capitalism’s natural life cycle.

So any discussion of profiteering which doesn’t focus on the fact that theory-legitimate capitalist profits no longer exist, only neofeudal rents, is false.

But since MMTers dream of a revitalized state capitalism, they’re invested in the same scam as neoclassicism, just with a different emphasis. But in both cases all democratic ideas have to be suppressed. Everyone can agree on that.

I’m usually with you, but you ask too much of MMT. It’s only a description of a state money system. You seem to expect a revolution. If you have a money economy within any sort of political system it will be useful to understand. Of course it can be used to further the status quo. So can any other system ever devised.

Would it be fair to describe the Federal Reserve as a government contractor? The Fed operates under the aegis of Treasury, but at arm’s length. The President appoints the Chairman of the Fed. But neither Congress nor Treasury asserts operational oversight of the Fed. Monetary policy is in effect contracted out to the Fed. When the Fed wants physical money, it buys it for the cost of production from the Treasury Department’s Bureau of Engraving and Printing. Federal Reserve Notes are legal tender because the Treasury and the US government allow them to be legal tender. Although the Fed is largely independent, the Treasury and the Fed work together in close cooperation.

I’m still working on Randall Wray’s Understanding Modern Money, but it seems to me that it would be useful to view FRNs as private money, which the government accepts for payment of taxes. And it would also be useful to view Treasury notes as public money or government money. In practice we only ever see private sector FRNs, but the system would be somewhat different if the government were to insist on Treasury money for payment of taxes. Why bother with an exchange mechanism? Just use FRNs for everything. (Same principle applies to the electronic version of money.)

Not only have I heard of the Federal Reserve Act, I have actually read it.

But here are some facts that you need to wrap your head around, Jeff:

1) The Federal Reserve is a privately held bank, not a state agency.
2) Empirical evidence presented by the Fed itself shows that commercial banks create money by lending it 9-12 months before the Fed creates reserves.
3) this means our current money system is (a) endogenous and (b) created through the private extension of debt.

In other words, my friend, we do not have a state or sovereign money system, we have a private debt-based money system. The empirical evidence demonstrates that fact. One of the reasons MMTers aren’t more successful is that they don’t point this fact out, even though they are well aware of it. Indeed, they’re engaged in a bit of econo-aikido, using the lies of neoclassical economics and the fiction of sovereign money to actually achieve sovereign money.

Please pay attention.

By the way, the rudimentary outline of these facts can be found in a Steve Keen post that Yves cross-posted here at NC back in 2009:

The Fed and banking system exist due to legislation and their continued existence is at the leisure of Congress. For this reason they cannot be private even if they are privately owned.

State money derives its value from its ability to extinguish a tax liability and is furthered by legal tender laws – neither of which have anything to do with the Fed and private banks.

In the strictest sense, banks do not create any money when they lend. They create claims on money (bank deposits) with a corresponding debt. The two of these always net to nothing.

If bank deposits are withdrawn or transferred from the bank, the bank needs to have real money (reserves) to do this. Without access to the reserve payments system your bank deposit is only “money good” at your bank. Banks can’t get access to this system without a govt charter or license. This makes them govt sponsored entities.

Jeff, when we distinguish between public and private in this context, we’re merely referring to the presence of private rent-seekers, in this case banksters. We’re not referring to some mystical distinction between “public” and “private” power. We recognize no such distinction. That’s part of our attack upon liberals and conservatives, that to the extent they really believe their ideologies, they go in for such superstitions about power, when they’re really both the dupes of power as such. (The imbecility of thinking there’s a difference between Dems and Reps is, intellectually, just a microcosm of this.)

Jeff65, you merely repeat a carefully constructed fiction, part of which, at least by implications, is the misleading term “separation of powers”.

You wrote:

“In the strictest sense, banks do not create any money when they lend. They create claims on money (bank deposits) with a corresponding debt. The two of these always net to nothing.

If bank deposits are withdrawn or transferred from the bank, the bank needs to have real money (reserves) to do this. Without access to the reserve payments system your bank deposit is only “money good” at your bank. Banks can’t get access to this system without a govt charter or license. This makes them govt sponsored entities.”

“In the strictest sense”. What does that mean, really? Because someone somewhere calls notes and coins and Fed-created money “high powered”? Because commercial bank-extended ‘credit’ “nets to zero”?

Well, money created by the Fed is borrowed by the government via sale of bonds, treasuries, etc., via the Fed. That “high powered money” is therefore just as debt-based (i.e. just as credit-like) as commercial bank created money. As to “nets to zero”, check out the money supply. Growing like cancer all over the shop. Indebtedness rife across the nations of the earth. No “nets to zero” anywhere I can see. The only usefulness the term “nets to zero” has is in implying debt collapse in a system which, if it isn’t growing, is collapsing. Should all debts be repaid, including government debt, there would be zero money in the system, real or credit.

Actually, it doesn’t really matter whether we say publicly or privately owned; with money-as-debt and interest-bearing to boot, we have a pyramid scheme, a Ponzi, a Madoff. When it stops growing, it starts collapsing. It is also a mechanism for redistributing wealth from the poor to the rich. (A recent pronouncement by a European Central Bank responded to an Austrian citizen’s accusation of the money system as a pyramid scheme, by asserting it could not be, because savers at banks are not required by banks to bring in new savers. By that same logic, Madoff’s system was also not a pyramid scheme!)

Finally, the bank deposits you refer to are owned by their account holders, not by the bank; these so-called reserves are therefore the bank’s debt. Furthermore, to say credit-money is a claim on real money is to ignore the fact that the ‘real’ money is likewise a claim on money, and was likewise created as debt. With what do banks and other financial institutions buy government debt in the first place. ‘Real’ money or ‘credit’ money? And what about notes? “I promise to pay the bearer on demand the sum of five pounds” adorns the British 5 pound note, for example. Money backed by money, credit backed by money, all of it originating as debt and ultimately backed by economic growth, exponential growth at that. Hardly a wise system.

And what happens when a bank extends credit? Is it somehow marked as credit throughout the system? If I borrow 10K to buy a car from you, and you deposit that 10K in your bank, does the system perceive that money as credit-money? Of course not. You can now remove that 10K as cash and do with it what you want. No way the system wants to know what is ‘real’ money and what is ‘credit’ money.

Ergo, the distinctions you reference are misleading casuistry, a deception we all need to penetrate and reject.

I agree with you. What I disagree with is the context in which Tao first mentioned a private money system in his response to me. It implied that the US system is not properly described and analysed as a chartal or state system, which is absolutely incorrect.

Toby,

I disagree with nearly everything you’ve said regarding your analysis of the system.

apologies. I reread my post and noticed it was more aggressive and bellicose than it seemed to me at the time of writing. It was also poorly written.

Also, I have to confess, there was indeed an error in my knowledge, which somewhat synchronistically was corrected last night by a book I am currently reading (“Sacred Economics”). My error was in not recognizing the difference, at the operational level, between a debt as originated by gov’t via a bond or treasury etc., and as extended by a commercial bank. In the long run, over multiple decades, and when many other things are taken into account (e.g. the finite nature of the planet’s resources), this difference isn’t as important as a narrow rendering of the money system would suggest, but perhaps that is a discussion for another day.

Nevertheless, “nets to zero”, though true in theory (and in the practice of debts being repaid and disappearing, with interest merely a ‘redistribution’ of already existing money) is likewise only narrowly true. Isn’t Too Big To Fail evidence of this? Isn’t the data in Keen’s “The Roving Cavaliers of Credit” evidence of this? Credit money, which is as effective as high powered money in terms of buying and selling, and even though it only represents claims on high powered money, is vital to the economy. And its creation precedes or even initiates the creation of high powered money (cf. Keen). Although on a loan to loan basis credit nets to zero, seen systemically and over time it does not, nor can it be allowed to. If reserves are only 10% of what an economy needs to run smoothly, the moment to moment repayments of commercial bank loans must exist against a backdrop of new loans which, on the whole and because of interest, must increase in quantity. The data appears to back this assessment up. For day to day purposes, credit money is exactly as effective as high powered.

Hopefully this was an improved formulation of my position. Again, sorry for the tone and quality of my other comment.

We have faux private banks which are backed with govt money. Its true that we ACT like our money system is private, but its a sham. When you have your liquidity guaranteed by the govt you have govt money.

You invest your money in materials and labor to produce something that then goes on to produce more than you invested…i.e. an olive tree that might last for
thousands of years and keep a collective hundred human beings alive with the fruit it produces.

Compare that to some poor slob working for three hours in a fast food terminal who takes what’s left of their earnings after taxes and goes to a movie theater where they sit and imbibe carbonated HFC slop and a bag of corn while watching the advertisements and then the courtesy movie that accompanies the “food” and the ads.

They could have taken the same money and time and gone and bought a fruit tree, dug a hole and planted it.

In a way, the corporation that owns the theater is helping to plant a seed of future profitability by prompting the human mule to want more of their products and to keep coming back over and over again.

Excellent comment. I believe it was Marx who first pointed out the “disappearing profits” concept in capitalism, but it’s good to know that formal capitalism texts have also made note of this.

As for MMT, I’m a major fan, but I too have noticed what I consider to be a weak treatment of this therein (although I would phase it differently, perhaps due to my MMT background). To MMT, taxes are supposed to take care of this, but exactly how a tax regimen might be developed that did so is left out. Obviously, there would have to be some very specific identification and targeting by this tax regimen, but to date, I’ve not seen this discussed. I’ve been trying to find a way to introduce this question into the discussion of late, and I would certainly encourage you to continue to do so also.

Thanks. The MMTer emphasis on taxation is another objection I have to it, and another proof of their superstitions about “good government” and their practical will to big, aggressive government. They are, at least, relatively honest about the fact that taxation is not a fiscal necessity but an instrument of social domination and control.

Nice introduction.
The point about government spending offsetting savings especially (though it seems to ignore demographic issues, so that it seems of rather little use in, say, a country with an aging population living off its savings); hadn’t seen it before. (Though a big issue would be that the govt would have to fund ever larger amounts of money as the economy grows, if the savings are a percentage of total amount of money floating around in the system; which is probably unsustainable unless you cap savings.)

Quibble:

When looked at closely what we have outlined above must come across as rather strange. The profits that the capitalist receives come from investment. Since these profits are then deployed to finance new investment – or, at the very least, are taken into consideration when taking on new financial obligations to fund new investment – we arrive at a strange loop, a sort of ‘snake eating its own tail’.

Compare this very simple account, which ignores government as an investor:

But let’s stick with the simple version: how do capitalists both consume and pay for the surpluses they have been instrumental in getting labor to produce? The surplus can be consumed in two ways –- as capitalists’ personal consumption or through investment in expansion –- hiring more laborers and purchasing more means of production. The latter implies perpetual growth and accumulation of capital over time. It also conveniently means that the demand for expansion tomorrow can absorb the surplus product created yesterday.
But there is a timing problem here: the expansion the next day does not realize its profit in money form until the end of that day when the money was needed yesterday to purchase the surplus then produced. The only answer is credit money backed by the promise of future expansion of surplus production. This is what allows the circle to be squared, provided, of course, the future expansion actually occurs. If not, we have a crisis in which the debt cannot be paid.

The perpetual accumulation of capital and of wealth is therefore crucially dependent upon the perpetual accumulation and expansion of debt. These two variables – accumulation of capital and the accumulation of debt – have in fact run alongside each other in the history of capitalism (go look at the data), both feeding and supporting each other. They occasionally get out of sync to create a crisis of the sort recently witnessed. What looks like a crisis of Greek sovereign debt is in fact a crisis of the financial system which arises because of a failure to find new ways to expand the surplus through reinvestment!

I think that’s David Harvey, if my Google is working properly. To be honest I thought it was Marx. Harvey is certainly one of the best Marxist writers around at the moment — given that I mistook his style for the master himself (and I like to think I’m pretty good at recognising writing style).

The model I presented is Michel Kalecki’s. Kalecki was very much influenced by Marx but there were two key differences that grate with what Harvey wrote:

(1) Harvey clearly presupposes a labour theory of value. He says quite explicitly that a ‘surplus’ is extracted from the workers. Kalecki called the LTV ‘metaphysical’ and completely dismissed it.

(2) Harvey ignores the government sector. Marx could have done this no problem — he was writing around 1870, after all. Harvey cannot. Kalecki was well aware of the government sector and it’s importance in the early 20th century; I’m surprised Harvey hasn’t caught up. Considering the government sector leads us to ask the question: is government fiat really debt? Is it ever paid back? What is its function? So, an MMTer would say no to Harvey. All expansion is not debt-driven. Only some private sector expansion is debt-driven. The rest is run on government deficits — which are not debts.

What really surprises me is that in ignoring this he’s trailing far behind Paul Baran, Paul Sweezy and Harry Magdoff. I would have thought he would be familiar with the three leading American-based Marxist economists of the 20th century…

I’m familiar with Harvey’s work. He’s way behind the old American Marxists on fiscal policy. Compare his work (see p. 309 second paragraph of ‘Limits to Capital’ — I’m not typing it up, sorry) with the old American Marxists work.

Harvey still thinks that ‘crowding out’ takes place. He also claims in a footnote on that page that Keynesians have the same theory of money as monetarists. So, yeah, Harvey is way behind his predecessors on this stuff.

is government fiat really debt? Is it ever paid back? .. an MMTer would say no…. government deficits — which are not debts

That’s quite wrong and is not MMT, and is the wrong way to think about things. Read Mitchell-Innes, or Wray’s Modern Money Primer, or even look at a dictionary under “debt”. Government fiat money, like all money, is debt, a perfectly ordinary, the most ordinary form of debt, and “it” usually is paid back fairly quickly in modern, high taxation mixed economies. (May take some work to ascribe meaning to the “paying back” but I hope you see the idea.) Governments just keep net issuing more debt/money & there’s compound interest, so their debt keeps growing, but that is different.

It can be unpayable – in real terms, whatever you want that to mean – just like private debts. We just call the discounting of government paper “inflation”, and the eventual discounting of private paper “default” or “bankruptcy”.

Government fiat is not debt — at least if you remove the silly gold standard constraints now on it. Insofar as the government debt keeps growing it is never really paid back. The sooner we see that government fiat is not debt, the better.

Government fiat is more so a government demand that you work for them. I give you this, you pay taxes with it, you do what I say (build a road etc.).

Good for you Philip! If there is any debt necessarily associated with fiat it is from the taxpayer to the issuing government. But as usual, the usury class wants to pretend that government must borrow from them.

“If the Nation can issue a dollar bond it can issue a dollar bill. The element that makes the bond good makes the bill good also. The difference between the bond and the bill is that the bond lets the money broker collect twice the amount of the bond and an additional 20%. Whereas the currency, the honest sort provided by the Constitution pays nobody but those who contribute in some useful way. It is absurd to say our Country can issue bonds and cannot issue currency. Both are promises to pay, but one fattens the usurer and the other helps the People.” from http://quotes.liberty-tree.ca/quote_blog/Thomas.Edison.Quote.6991

Government fiat is not debt — at least if you remove the silly gold standard constraints now on it. Insofar as the government debt keeps growing it is never really paid back. The sooner we see that government fiat is not debt, the better.

Philip, (fiat) money, including the form of money called “government bonds” is the most important form of debt in the world. Whether MMT is right or not is a separate point [it is], but whether fiat money, all money is debt according to MMT is not seriously disputable, unless you don’t consider Wray (and others) MMTers, unless you think Mitchell-Innes, Lerner etc to be misguided.

Thinking of money as debt is the fundamental principle of MMT, from which everything else flows, that makes everything simple and natural. Again, read Mitchell-Innes & Wray’s Primer (& the comments & responses). Ingham’s book The Nature of Money is another excellent source. What you are saying is false and violently contrary to MMT. Thomas Edison, as quoted by F. Beard below understood (fiat) money is debt, as did FDR.

Suppose we scrap the labour theory of value and assume that the surplus occurs because of the “contribution” of property, whether nature or real capital, to the production process and to the creation of value.
The problem with property’s contribution–and return–is that property itself, of course, can buy nothing. And its owners can only keep the system from jamming by becoming consumers themselves. (Note: Business costs and real investment are not necessarily logically excluded from “consumption,” as becomes obvious when a business turns into a non-profit. The difference in “consumption” and “production” is the motives of “consumers” and “producers” for spending.)
Property owners, unlike most workers, usually have the option of not consuming, and thus can easily become savers. And, as is well understood, this can cause capitalist crises. The labor theory of value seems to me a red herring. Property is essential, although to read economics textbooks one might assume workers create goods out of thin air. What’s important is who controls the property, how do they manage it, and how is their ownership justified and legitimated.
A good island-economy book , from 1935, is by Willard E. Hawkens, Castaways of Plenty: A Parable for Our Times. In the 1930’s many understood both the productive power of capitalism and the dangers of debt.

Every company wants to increase revenues and lower the costs. When the company lowers salary to its workers, it usually has negligible impact on its revenues, as little of the demand for the company’s products comes from its own employees. At the same time, if the company passes the lower labor cost to its consumer via lower prices, then the society as a whole benefits from this process as it makes the economy more efficient.

However, when all companies lower salaries to their employees, it suppresses the aggregate demand in the whole country. The net impact on the economy might well be negative. This effect is indeed quite similar to the paradox of thrift. One could call it “a paradox of cheap labor”.

In the past, up until early 1990s, there used to be a feedback link that mitigated this coordination failure: the company owners would consume a small part of the profits, and then would reinvest the rest back into to the economy of the country, as they did not have any other options. Whether such reinvestment turned out to take the form of investments in the stock market, or corporate bonds or even government bonds was not important – the savings stayed within the country and got recycled back into the economy.
Today, however, this feedback link has long been broken: capital gets invested abroad, both by corporations and by wealthy individuals. Even investments in Treasuries are not going back into the economy as much of the increase in the US Federal debt level was to fund wars and absorb the negative shocks of the Great Recession. As a result, the growth in corporate earnings does not affect the real economy in the home country as much as it used to.

The society needs to address this failure of coordination and support the aggregate demand through taxes and social support, which is in the long-term interest of both employees and companies, which need strong market for their own goods and services. Alas, the value for each company to defect from this coordinated effort is just too much – we are all “prisoners” of the dilemma of self-interest vs. common good.

“In the past, up until early 1990s, there used to be a feedback link that mitigated this coordination failure: the company owners would consume a small part of the profits, and then would reinvest the rest back into to the economy of the country, as they did not have any other options. Whether such reinvestment turned out to take the form of investments in the stock market, or corporate bonds or even government bonds was not important – the savings stayed within the country and got recycled back into the economy.”

I don’t think this money WAS being reinvested. I think it was going into speculation (dot-com and then housing bubble). And I think it was these private sector debt bubbles that were responsible for growth. (Actually, the dot-com boom was probably moreso profit freed up from taxation in the 1980s and the like rather than debt, but it was still the speculation that was the driving force).

If we go further back to 1980s it is quite clear that Reagan was running the economy on deficits — specifically for military expenditure (‘military Keynesianism’ as its called).

This leads to your next point — which, I’m afraid, is something of a cliche:

“Today, however, this feedback link has long been broken: capital gets invested abroad, both by corporations and by wealthy individuals.”

I don’t think that’s the problem at all. The current crash and protracted downturn has a vary specific cause — and a rather obvious one: lack of aggregate demand. This originally caused a flight into private sector debt and now its leading to unemployment. The ‘they tuk our jiiiibs’ lines is just a distraction. It’s a convenient way for the business class to sell their propaganda about Big Guv’ment to the masses. (I.e. “We’re living beyond our means — we need to be more like China”). If these people are listened to the situation will get much worse.

I have a real problem with the idea that our present problem is as you say “lack of aggregate demand”. I would prefer to see it that the real problem is worldwide unsustainable debt levels. During the build up of those debt levels, we all enjoyed growth but has larger that debt become as harder it is to create growth. To now resolve the present problem of too much debt with more debt on top of the previous one, does not really solve anything but extends a resolution. To dilute the currency also does not resolve it in my opinion.

To me high level of debt compares to a fat person trying to perform a physical task. It just becomes harder and harder as more obese he is. If you feed him more in order to make him stronger, all you do is make him more fat.

Well, in relation to the above presentation we draw a pretty specific conclusion: all profit/money is debt. To quote the famous testimony given by the great central banker Marriner Eccles:

“Chairman of the Federal Reserve Board, Marriner Eccles testified before the House Banking and Currency Committee September 30, 1941. He was asked by Congressman Patman, “Mr. Eccles, how did you get the money to buy those two billions of government securities?” Eccles replied, “We created it.”

Patman asked, “out of what?” Eccles answered, “out of the right to issue credit-money.” Patman then asked, “And there is nothing behind it, is there, except our government’s credit?” Eccles responded, “That is what our money system is. If there were no debts in our money system, there wouldn’t be any money.””

There is no ‘fixing’ this ‘problem’. It’s not even a problem. The question is: to whom we assign the debt? The private sector? Or the government? Until people get their heads around this we’ll be chasing our tails.

But Philip isn’t this what Linus is saying. During the 90s aggregate demand was fueled by private debt in lieu of increased spending power. At a certain point service of this debt became so high that there was no surplus income to spend with. Thus the drop in aggregate demand we see today. He is pointing out that the debt existing in the private sector is causing this drop.

Actually, he may have been saying this. I have a bit of a knee-jerk reaction to phrases like ‘worldwide debt problem’ because these usually mean that governments are also loaded with ‘too much’ debt — which is the solution, not the problem.

You’re right though, the above comment could be read either way. I apologise if I misrepresented it.

Let me add here that for a while giving a person lots of high calorie foods did probably work but we now reached a level that will endanger the guy to get a hard attack rather than being able to perform at a better rate. The only way to resolve it, is to loose weight. Until now all and everyone has been fighting to go on diet.

“I don’t think this money WAS being reinvested. I think it was going into speculation (dot-com and then housing bubble)”…

They would seem to have taken precisely some of that into account as they said “up UNTIL the early 1990s.” They also likely could have said “in the US.”

I do think this whole discussion is taking place in an ahistorical bubble. While clearly not big on history, the economics profession does have some set pieces: “Roosevelt II,” “In 1929,” “Weimar Germany,” “1984” etc.

However, no one would ever mistake it for a reality based discipline, and thus it seems that the moribund academy has yet to integrate into its set formulae the real economy of the past 25 years or so, in which if anything the pace of change has accelerated.

Commenter: ““Today, however, this feedback link has long been broken: capital gets invested abroad, both by corporations and by wealthy individuals.””

Pilkington: “I don’t think that’s the problem at all. The current crash and protracted downturn has a vary specific cause — and a rather obvious one: lack of aggregate demand.”

It is formulaic ahistorical economese to chant like an autistic simpleton that “the problem today is lack of aggregate demand” without looking at the many contributaries to the situation described by that silly catchphrase.

But the reason you give that formulaic answer is clear. Your religion dictates that the ONE AND ONLY solution to “lack of aggregate demand” is “government spending,” and you’re on the warpath–just about everyday–promoting government spending. (What you want to spend it on, I have no idea, but since your religion dictates that it doesn’t matter, I don’t expect to hear).

Even if you could refute this person’s comment– I don’t know maybe you can– you certainly *haven’t* done so merely by ritualistically invoking your favored “lack of aggregate demand means government spending” formula.

If it’s not clear by now that not everyone is going to pray from that hymnal or else STFU, I don’t know what to tell you.

So, go back to your hypothetical expanding loaves of bread and fishes up there on Mt. Olivet or whatever. No need to do any research.

“But the reason you give that formulaic answer is clear. Your religion dictates that the ONE AND ONLY solution to “lack of aggregate demand” is “government spending,” and you’re on the warpath–just about everyday–promoting government spending. (What you want to spend it on, I have no idea, but since your religion dictates that it doesn’t matter, I don’t expect to hear).”

Actually, I used to think the problem today was to do with increased competition in the world. (I broadly adhered to Robert Brenner’s argument). However, upon careful study I came to realise that policy cannot counteract this; that we in the West don’t want to be doing what the Chinese and Indians are doing and that the key problem in the West is unemployment (which is due to aggregate demand) and not fiendish foreigners taking our jiiiiibs.

But this won’t make sense to you because you occupy a world in which the people that disagree with you bear ominous opinions derived wholly from political obsessions with full employment or whatever. You couldn’t imagine that someone could have engaged better or less-well with a reasoned argument than someone else or that someone could move from one opinion to another based on reason and careful study. It all has to be very nefarious. Good and Evil. Right and Wrong. And I’m the religious one, sure…

Umm… I don’t think this money WAS being reinvested. I think it was going into speculation (dot-com and then housing bubble).
There was no dotcom or housing bubble before 1990

The current crash and protracted downturn has a vary specific cause — and a rather obvious one: lack of aggregate demand.
But that’s the key question at hand, isn’t it – why is there lack of aggregate demand when the corporate profits have fully recovered and are at record levels? Surely the companies themselves are very much interested in stimulating aggregate demand as a means to boost their sales. The problem is that the optimal strategy for a typical company is to reduce its labor cost while hoping that everybody else will in fact stimulate aggregate demand.

As I said, prior to the 90s the economy was relying on large budget deficits to supply sufficient demand.

And, yes, what you say about companies reducing costs is a big part of the problem. I’d add to that that up until recently they were channeling their profits into the finance sector (not sure how that’s going at the moment).

But this isn’t in response to some ‘flight of investment’. This is simply what economists call a ‘deflationary spiral’. It happened in the 1930s too — and in Japan recently. It has to do with debt deflation, not flight of capital. Flight of capital is the ideology of the business class who use this trope to justify their slashing costs and destroying the domestic economy.

(Sorry for the misunderstanding re: the 90s, I was responding to a lot of stuff yesterday.)

What you’ve nicely highlighted here is the Paradox of Productivity that you get in a purely private system.

Once you have machines capable of producing for all (the bread factory) without employing everybody in the economy then it makes no sense to produce for all because less people have income to buy the output.

That’s why you have boom and bust. The system supports itself while there is a ‘greater fool’ entrepreneur investing, but once that stops the whole thing collapses.

And that’s why you need the dampening effect of the government sector operating in a counter cyclical fashion.

Or you can be like the neoclassical economist in Europe and try and export the problem to Spain, Portugal, Italy and Greece.

So, let’s see: in order to keep a positive driving force, Profits – Tax must be > 0, possibly >>>0.
This is not going to be achieved through Capitalists’ Consumption (they wouldn’t be capitalists if they spent all their money – or they would be broken ones).
Positive Net Exports could be a temporary solution, but it’s just a way to export the problem abroad, which in a finite world is something going to backfire sooner or later.
Gross Investment might be part of the solution, provided that capitalists are prone to invest most of their profits, still it will never be quite sufficient unless GI becames greater than Profits, which means that Capitalits (or Firms) raise debt.
Workers’ Saving cannot contribute unless they are negative, so we have debt again.
Government Deficit means debt.
My personal conclusion: profits require ever growing debt.

The only question is: which sector should go into debt? And that leads to the question: are government deficits actually debt.

The above model is Kaleckian. But my answer to those questions would be in keeping with MMT. I.e. government debt isn’t really debt; at least not under a fiat currency regime. This leads to some fairly simple conclusions… at least, I think so.

Yes but I see two problems:
1) new money will lead to inflation once drips down to consumers
2) new money (perhaps most of it) will stay with capitalists, and sooner or later it will outweight the amount actually exchanged in “real” economy… so a fantasy economy will be created in order to keep it moving and used to produce real profits…

Not in the model I lay out in the piece. Have another read. Notice that Roosevelt II spends only until full employment is reached. It’s with Nixon II that the inflation take off. Why? Because he spends past full employment.

“2) new money (perhaps most of it) will stay with capitalists, and sooner or later it will outweight the amount actually exchanged in “real” economy… so a fantasy economy will be created in order to keep it moving and used to produce real profits…”

That is certainly happening today. And MMTers are well aware of it. See:

The question is how we deploy the stimulus (i.e. government spending). In my model Roosevelt II hired the workers directly, ensuring most of the stimulus didn’t go to profits. This is why MMTers favour a Job Guarantee program or, at very least, direct jobs programs ala the New Deal’s NRA or Hitler’s works programs in the 1930s.

Thanks for the explanation and the interesting link.
I still forsee a difficulty in applying Roosevelt II recipe: full employment means higher wages and lower profits, so when there is no protectionism and capitals can flow abroad this will eventally kill the economy through very negative Net Exports and very small Gross Investment. Can be sustainable for some time provided that the “domestic” money is accepted in unlimited quantity abroad, which is what has happened with $… for now.
It might work better in a close system though (i.e. applied worldwide).

I’ve been giving some thought to this matter in addition to working a lot on MMT lately.

I think I’m finally starting to get the hang of it.

Here’s what I’ve come up with so far:

Assume a non-corrupt government devoted to public good. Let K (t) denote the capital existing in period t and N the flow of labor services used at time t for production. Assume N to be fixed. As my model exhibits constant returns to scale, the dynamics will not be affected if we allow the population to change at a constant growth rate over time. We use the conventional production function to describe a relationship between inputs and output. The function F (t) defines the flow of production at time t. The production process is described by some sufficiently smooth function, F (t) = F (K (t), N). We assume that F is neoclassical.

Assume that agents have perfect foresight with respect to all future events and capital markets operate frictionless.

Assume a benign government that levies no taxes and exhibits no features of kleptocracy. Money is introduced by assuming a central bank distributes at no cost to the population a per capita amount of fiat money M (t) > 0 The scheme according to which the money stock evolves over time is deterministic and known to all agents. With u being the constant net growth rate of the money stock, M (t) evolves over time according to the following:

M (t) = (1 + u) M (t-1) u > 0

At the beginning of the period t, the perfect government brings M (t) – M (t-1) additional units of money per capita into circulation in order to finance all government expenditures via seigniorage. For the seigniorage mechanism to work, injections of the additional units of money take place before the other markets open. Let m (t) stand for the real value of money per capita measured in units of the output good, that is, m (t) = M (t) / P (t)

So there you have it, folks: MMT is merely a tool, kind of like plumbing, how it’s used depends whether you have a good plumber or a bad plumber using this tool. If your toilet bowl stops flushing you need a good plumber to unclog the shit out of the system, and it’s exactly the same with MMT.

Interesting model — I’d have to go over the details. But it does appear at first sight to be a bit ‘pie in the sky’. I assume that it’s using classical/Marxist assumptions. For example:

“N the flow of labor services”

How do you measure ‘labor services’? Are we talking about a nominal wage? A real wage? Or are we assuming a labour theory of value? If we assume the latter how do we give it a nominal value? An equation is only as good as the variable plugged into it.

To be honest, I’m averse to too much algebra. It often clogs up thinking. This is a serious problem in neoclassical economic. Try writing out your equation in English and you’ll see the presuppositions much clearer. Once you have this done then you might think of formalising it.

Ha! You’re right. It is, in essence, tied up with the GDP accounting identity. That’s why people said that Kalecki was the ‘left-wing Keynes’ (the latter having come up with the GDP identity). All these identities stem from the same macroeconomic logic — which makes it even more amazing that neoclassicals pick and choose which they accept as fundamental and which they ignore!

Yes, you can add the expenses back if you want to call it that. I prefer this way because it’s more conducive to explanation. But there’s a lot of ways of doing this. If you want a really complex breakdown try the Levy profit equation — info here (but you’ll have to buy a JSTOR paper [also below] to actually see it):

As for my long-winded explanation: not everyone is so familiar with the GDP accounting identity as you. Yes, I could have just written Kalecki’s equation or linked to one of his many papers. But that wouldn’t have explained much. I’m hoping the virtue of this article is that its in plain English and can be followed by anyone.

The model I put forward wasn’t dealing with capital consumption (depreciation). If you want to think of it in terms of the above then it produces the same sort of ‘drag’ as the interest on the loan does.

As for conflating capital consumption and capitalist consumption, are you assuming that any expenditure on updating/replacing capital goods are going straight into the spending stream?

Are you sure you can do this? For example, would a mechanic hired to fix a machine not be paid a wage? And would this not be dealt with in the ‘workers’ saving’ (Sw) part of the equation?

Trying to get a grip on what is meant by the term “capitalists’ consumption”.

Looks like it’s calculated as a subset of normally defined household consumption. What does it mean? The consumption of a capitalist household? What elements of GDP are examples of “capitalists’ consumption”?

If I’m a capitalist and I buy a big screen TV, and all workers incomes, consumption, and saving otherwise stay the same, then my consumption will increase macro profits before depreciation (with other relevant simplifying assumptions).

In the bad old days, it would have just been what the bourgeoisie spent on their fine linens and wines, but today it’s a bit more complex as the ‘little man’ may be able to earn profits through the stock market etc.

I think the best thing to do — although I haven’t fully thought this through — is to think of every agent as both a worker and a capitalist. When they consume out of salaries/wages we count it as workers’ consumption; but when they consume out of profits derived from investment we count it as capitalist consumption.

You’re a step ahead of me in developing a decomposition that slices through any agent worker or capitalist.

I’m still trying to navigate the accounting reconciliation in a weird but pure world of non-capitalist workers and non-worker capitalists.

Still in that simple world, off the top, naively I guess, I find the conflation of gross investment with capitalists’ consumption to be EXTREMELY class oriented. For those so inclined, you kill the capitalist while he’s at work (investment) and kill him when he gets home for a cold one (consumption), because none of his activity 24/7 necessarily improves the lot of labour, so it goes. If workers wages and consumption are fixed, the capitalist both invests and consumes according to the noted feedback loop that creates his profit. It is a very class oriented decomposition of consumption in particular.

BTW, for accounting purposes, it’s easiest to view the capitalist as buying his big screen TV with profits that have been dividended out to him.

You probably know a lot more about the background to all this as developed by Marx and others, moving along with Kalecki et al.

Perhaps the more you move to your sort of mixed world, which is more the real world, the more artificial this point about segregating out capitalists’ consumption becomes.

Anyway, that capitalists’ consumption notion is what’s been throwing me off I think, including confusing it with capital consumption or depreciation, which to me is a non-class, non-controversial economic idea.

It is a very class-oriented way of viewing consumption, I agree. Kalecki grew up under Communism and came from Poland — which was, in the earlier 20th century, a very class divided society.

Kalecki often assumed that the workers don’t save (except contra to what a commentator has said below, his equation CAN integrate worker saving). This certainly reflects his politics as much as anything else.

I think we should take a historical perspective on this. The type of economy Kalecki starts with did exist at one point in time. And it is out of this system that our present system exists. You’re right, when we add distinctions like the one I propose the class distinctions fade into the background. We could even rename the variables — ‘consumption out of profits’ and ‘consumption out of wages/salaries’ if we wanted.

The JSTOR article on Levy and Kalecki is really good on all this (it’s by Levy’s son). It also sets out Levy’s equation. Levy was an American businessman, not a Soviet economist, so his version of the equation is much more… erm… business friendly. I prefer Kalecki’s because of it’s simplicity. Levy’s is VERY complex — although if we were to ever try to measure this stuff I think Levy’s would be better.

I really think you should read the article. If you want I’ll email it to you (don’t tell JSTOR) — provided you don’t mind putting your email address in the comments here or you have some other way around this (don’t want to upload it; JSTOR need their subscriptions…).

btw, there is a related “mystery” about profits that Steve Keen grapples with at times (maybe it’s the same one)

it has to do with some circuitist puzzle about where accounting profits come from

the answer of course lies in understanding double entry bookkeeping for bank accounts, and how interest income is treated through banking debits and credits; its actually no puzzle at all if you understand the accounting, which apparently a lot of circuitists didn’t (along with most mainstream economists)

I like Keen and I can only praise much of his work. But he is so unbelievably wrong on his monetary theories. Every time I bring it up with MMT folks they bite my head off. Apparently they’ve been explaining it to Keen for years.

I think where Keen goes wrong is that he assumes that when money is returned as a debt repayment to the bank that it is not destroyed but instead leads some phantom existence in the vault. I’ve always been baffled by this approach. It seems to lead to a myriad of confusions.

The government sector also seems conspicuously absent from everything Keen writes or says. He claims that ‘debt forgiveness’ is the only way forward. Well, why not deficits that offset the private sector paying down their debt?

Keen, I think, lives in a land without a government. And here’s me thinking he was Australian…

I think the best of Keen’s work that I’ve come across is when he shows that capitalist firms don’t operate in line with the theory of marginal utility. He shows quite clearly that they are in fact always raising and lowering prices in response to each other — but not in line with perfect competition; instead they’re always trying to see how much they can get away with!

As far as Keen and government go. I think if he ever integrated the government sector, his theories about debt would start to unravel pretty quickly. So, I doubt he’ll ever truly engage. Pity. He’s still a very original thinker though. And God knows we need more of them.

The Bible has an interesting take on profits. Profits are undoubtedly good yet it is bad to take them.
Example:

In you they have taken bribes to shed blood; you have taken interest and profits, and you have injured your neighbors for gain by oppression, and you have forgotten Me,” declares the Lord GOD. Ezekiel 22:12 [bold added]

So how does one make without taking profits? Reinvesting those profits is one way. Giving them away is another. But hoarding them is certainly condemned; even lending them out for usury is preferable to that.

Um, I think you forgot most of the quote as a inconvenience to your view. Let me requote:
“In you they have taken bribes to shed blood; you have taken interest and profits, and you have injured your neighbors for gain by oppression”

The problem is not to have taken “interest and profits”, it is to have profited from opression and war.

The Bible forbids the taking of interest from fellow countrymen in Deuteronomy 23:19-20 so your interpretation is at least partially unwarranted.

Furthermore, there is no real need even in a modern industrial society for usury or profit taking. Common stock as money allows the necessary economies of scale without the harmful wealth concentration.

What happened with the Marxist model in which profits are in fact generated by surplus value, i.e. the fraction of the product’s value that is not paid to workers but retained by the capitalist? That is how profits are made and that is why profits don’t work in the long run, because the demand is sabotaged by the very act of making profits. Sure: the capitalist does consume but it is a feudal-like elitist consumption that does not sustain an economy.

Hence the only way to keep profits and the economy is to plunder one way or another, either by colonialism/imperialism (plundering overseas at a military cost) or by means of state intervention (Keynesianism) in the form of inflationary public investment (which plunders everyone).

Again in the long run it is unsustainable and must collapse, but for decades (1950s-60s, late 1980s-1990s- early 2000s, this one fed on the credit bubble rather than state Keynesianism) it may create an illusion of sustainability and success.

I don’t know why Marx, the only classical economist able to see the whole picture and not simply fall to pointless delusions, is always sidelined. Well, I know: he is blacklisted as heretic in the Holy Church of our Lady of Fake Economics, aka economy faculties nearly everywhere. But even conservatives can as of late acknowledge he got the basics way too right.

Otherwise the introduction is very well explained, even amusing, Philip. It reminded me of a comic book by which most kids of my age in Spanish language areas learned basic economics in the 1980s, with ‘The History of Money‘ of Mortadelo and Filemón, known in English as Mort & Phil.

My favorite fairy tale is about the commonwealth. It is much like common stock. Look at muni bonds. But the fairy tale I really want to hear takes commonwealth to its logical conclusion: Save private capitalist enterprise by separating it from “labor.” Instead of referring to “labor” I want my fairy tale to refer to human rights: the right to have adequate food, shelter, health care, education and employment. If this part of demand, which is always exploited to the detriment of capitalism, is removed from the capital-labor equation, then capitalism can go on its merry way, and good luck. Let us just see if it can survive. A closed circle of taxation on the labor of humans (as in human-rights enterprises) and expenditures on human needs will survive if it isn’t raided by private capitalists.

If this part of demand, which is always exploited to the detriment of capitalism, is removed from the capital-labor equation, then capitalism can go on its merry way, and good luck. Susan the other

I would do this via separate government and private sector money supplies per Matthew 22:16-22 (“Render to Caesar …”). That way, government money mismanagement would not hose the private sector and vice versa. Furthermore, since the public could choose to use either the government’s money supply or a private money supply for private debts, competition would keep corruption in check.

Hi F. You make more sense to me as I go along. I think I’m so liberal I’m almost communist and you are so conservative you are libertarian. Funny. But, hey. If the Chinese can combine the two, I don’t know why we can’t.

Kalecki’s general model says that the higher the level of spending in the economy the higher the profits.

I think any neo classical economist could agree with that.

Your attack on Samuelson isn’t logically connected with the rest of your story, in my view.

I can recall from studying his textbook that he insisted that an adequate level of aggregate spending – from either the private or public sectors – was needed in order to get full employment of resources in the economy.

You are assuming a closed system. In reality, there are additional income sources other than pure wages. Each of the bakers and construction workers also has a garden. The capitalist also sells his product to the banker, the president and other overhead positions, so the workers don’t have to spend their entire wage to make the capital flow work.

Um, profits are usually covered, extensively so, in microeconomics. They are of secondary importance to macroeconomics, except on the income side of the NIPA accounts. Hence: meh.

The driving force on the macroeconomic side isn’t profits: it’s demand. Profits are the incentive for the capitalist to invest their money to meet that demand: it is not driving force. Without demand, you can’t make profits at all (duh).

Mr. Pilkington is confusing macroeconomics with “economics” as a whole, ignoring the very rich and complex microeconomics literature about how markets function in detail and how prices are built. This is the foundation of macroeconomics: given that the knowledge of these functions is presupposed (generally speaking, micro comes before macro in economics education, right after learning accountancy), hence they are usually not handled in detail. Pointing to this as a failure of macro is failing to understand microeconomics. Mr. Pilkington also tries to make the jump from a microeconomic example – his mythical island – to NIPA accounts.

That profitable investments generate profits to be further invested: duh. That does not, however, mean that investments as such drive investments: it means that profits generated by investments can be used for further investments.

Now, Kalecki takes the basic NIPA accounting identity that S=I (savings is equal to investment, even though some of that savings may not and usually isn’t local!) and turns it with a fatal error into the equation Mr. Pilkington uses: the fatal error is that he assumes that workers do not save: we know that in the real world, they do. This doesn’t make his work meaningless, but rather makes it rather more complex. At the end of the day, to use the vernacular of the NIPA accounting, gross national income (which is your basic gross national product minus net foreign income transfers) is what is being described by Kalecki, not net profits. Here his analysis gains meaning: income, however, is not profits in this sense. The two are not interchangeable!

The idea that by having governments spend until full employment is reached is a recipe for catastrophe, as we are seeing: simply spending does not necessarily generate aggregate demand, as many pork projects show (they generate high levels of profits for crony capitalists, but you cannot make the case that building an airport where no one wants to fly increases aggregate demand in any meaningful way outside of the immediate increase in construction activity).

Government spending cannot be simply increased until full employment is reached without causing deadly side effects, such as runaway inflation (or lack of supply), extremely poor allocation of capital and extreme corruption that lead to the collapse of state-run economies. The empirical evidence is overwhelming (see Eastern Europe, 1945-1990) and irrefutable.

Seriously: government spending does not increase profits at an aggregate level. It increases the profits for the cronies of the politicians, but at the cost of profits for others who would have used the capital more profitably. Government spending over and above its cash flow takes capital from markets in one form or another (it has to, according to NIPA cash flows).

Government supplies infrastructure that makes the working of the economy function better (avoiding, for instance, monopoly pricing and discriminatory pricing on rail lines); it makes and enforces the laws that make it possible to do business with others; government can even ensure that hiring practices are fair and without prejudices. It does not directly generate profits.

(1) I show clearly in the piece that profits rely on aggregate demand. Hence, why a deflation occurs when there is insufficient demand.

(2) Kalecki’s equation clearly allows for worker’s saving. What do you think the ‘Sw’ variable is for?

(3) Citing Communism as an example of how state spending will ruin everything is a pretty weak argument given that there are state capitalist models you could have referenced — you know, like every capitalist economy functioning today. I’m not a Marxist. I’m not advocating Communism.

(4) The inefficiency arguments are dry. Surely the housing bubble was inefficient? Capitalism generates inefficiencies too. As does state expenditure. Let’s not make value judgements.

Most microeconomics I think — and I won’t mince my words — is trash. Pure trash. Marginal utility, supply-demand curves… all of that stuff is rubbish that is, I think, largely meaningless.

Also, there’s no point in constructing a macroeconomic theory of profit on a microeconomic theory of profit. I dealt with this in the above (the child’s lemonade example). Microeconomics deals with how the child makes his money. Macroeconomics deals with where this money comes from given the broader economy. To derive the latter out of the former is more than simply foggy reasoning — it’s downright a priori nonsense.

Wow! It’s always interesting to hear all of this high powered reasoning and elaborate solutions to what should be a simple idea. Pay the workers more money. Its the easiest way to reinvigorate the economy.

This post is just awesome. Someday economics will take its proper place right next to the Theology Department in universities. Students who are interested will be able to learn about the MMT debate with the same sense of relevance that they can now bring to the study of how ancient theologians determined the divintiy of Christ. Keynsianism will take its place right next to the Antinomian heresy.

Unfortunately none of this will come to pass until these ideological battles play themselves out as they usually do by getting people killed. Only then can the next generation see the stupidity of all of this.

I really think that economics is the only “science” where the reality is forced to bend to the theory rather than the other way around. If physicians operated the same way we would end up all dead. Oh wait? They did at one time. Hmmmm.

Oh and I do have an economics degree. Sorry but it is just math put to words. Just like religion is only a good story.

Perhaps the real “problem” is that – like religion – economics is just the manifestation of (very fundamental) human brain attributes.

There’s the Mean-Daddy brain (Old Testament, Austrians), the Smothering Mommy brain (New Testament, Keynesians), and all the various shades in between. (which ones are the Buddhist economists?)

As with religion, the economic theories exist inside the ”reality” created by each brain. Self-delusion allows the true-believer to see their religion as matching “real reality”. (The US anti-space-alien defense program bring perpetual prosperity to all).

I do appreciate the earnest attempts being made to perfect an economic model. Our monetary-social interchange is surely a holy grail and deep mystery, replete with competing priesthoods. The world would be grateful if the models could be perfected, but such has yet to be concocted, one that could avoid war (or alien invasion) and misery for the masses.

My request to those sequestered in the ivory tower is to not be so arrogant and classist with gems like, “they tuk our jiiiiibs”. The jobs are missing, along with retirements plans, healthcare and social security. Your condescending attitude to those who are suffering, who have had their lives turned upside down, to those denigrated while living in the country that went from the richest to the most absurd is why both your science is dismal and guillotines are back in vogue.

If full employment led to higher profits, wouldn’t the capitalists insist that the government pursue such a full employment policy? Full employment would lead to higher wages as the working class would be in a position to demand such increases. If I recall it was the classical economist David Ricardo showed that higher wages produced lower profits.

That’s attributing a lot of smarts to capitalists — and I don’t think that’s quite justified.

Ricardo did, I think, show something of the sort. This is where Marx derived his ‘labour theory of value’ and consequently his ‘surplus theory of value’. Ricardo was wrong — on a lot of things. He didn’t, for example, think that rising wages were possible in a capitalist system. Well, he got that wrong, for one.

Interestingly though, Rob Parenteau gave me a lot of feedback on this (thanks again Rob, if you’re reading this) and he pointed out that if neoclassical economics is really pushed, it can only explain profits in the marcoeconomy by adopting Marx’s theory of surplus value. That’s a topic for another post, I think.

“Political Aspects of Full Employment. Why doesn’t the business community step up and demand more investment?

We shall deal first with the reluctance of the ‘captains of industry’ to accept government intervention in the matter of employment. Every widening of state activity is looked upon by business with suspicion, but the creation of employment by government spending has a special aspect which makes the opposition particularly intense. Under a laissez-faire system the level of employment depends to a great extent on the so-called state of confidence. If this deteriorates, private investment declines, which results in a fall of output and employment (both directly and through the secondary effect of the fall in incomes upon consumption and investment). This gives the capitalists a powerful indirect control over government policy: everything which may shake the state of confidence must be carefully avoided because it would cause an economic crisis. But once the government learns the trick of increasing employment by its own purchases, this powerful controlling device loses its effectiveness. Hence budget deficits necessary to carry out government intervention must be regarded as perilous. The social function of the doctrine of ‘sound finance’ is to make the level of employment dependent on the state of confidence”.

By my calculations the entrepreneur ends day 1 owning a bakery but owing the bank $1 for the interest on the $10 loan. The $10 paid out in wages is exactly offset by the $10 received for the loaf of bread.

Yeah, the wages ‘wash through’ and come back to the capitalist as the workers pay for their bread. This leaves the capitalist with $10. He pays out $1 in interest, leaving him with $9 and a bakery. He then moves onto his next investment.

We expect the economy to expand in the medium to long-run, giving the capitalist more and more income with which he can both turn a healthy profit and meet his loan obligations. If not or if at too slow a rate, you’re likely to see a lot of bankruptcies and bank failures. See: the US in the 1930s!

In fact, I took most of the above model from Hyman Minsky’s ‘Stabalizing an Unstable Economy’. Minsky thought the profit cycle was key to debt repayment (or non-repayment) issues. Minsky describes in detail how a lack of profit can send a capitalist from a ‘hedge’ to a ‘speculative’ and ultimately to a ‘Ponzi’.

And this is where the profit equation ties in with the Minsky Instability Hypothesis. Fascinating equation, eh?

Once thing I find amusing is that the simple scenario you present is probably the perfect propaganda scenario for people with Libertarian leanings who want to demonise the fiat currency system we currently operate under.

If some form of private or commodity backed money became the norm most of the things underlying your model would not apply.

Maybe I’m an idiot (although I did go to an Ivy League school on full scholarship, I speak six languages, and I have worked as a database programmer for a few investment banks)… but this post moved me to send the following email to a friend of mine:

A propos of nothing, here’s a post today on NakedCapitalism about profits in macroeconomics by a guy who’s presumably well-versed and well-intentioned:

It’s about a simple topic (profits) and it’s presented in a simplified fashion (using an imaginary economy on a tiny island)… but my point is: in the end, like nearly all writing about economics, it is absolutely incomprehensible to me (particularly once you read through the comments as well).

I’ve tried off and on for decades to wrap my mind around economics and get some idea of how the whole thing works (or should work) – but I never really seem to get anywhere. On one hand, our current economic system does have a few good things (I can walk into a store and buy stuff)… but on the other hand, it seems like a total disaster (most other people can’t walk into a store and buy stuff – and the planet seems to be dying because of something seriously out-of-kilter in our economic system).

I feel that I have a fairly clear rudimentary understanding of most other fields such as biology, chemistry, physics… and even “softer” sciences such as sociology and psychology – gleaned over years of reading bits and pieces here and there which for the most part have been fairly consistent and have added up into something resembling a coherent body of knowledge.

But pretty much every time I read something about economics, I notice the following:

– the writer seems to be attempting to stake out a tiny piece of fresh territory from scratch: laying out their own peculiar set of assumptions, dealing with an oversimplified situation, and pretty much ignoring or outright denying 90% of what has already been said elsewhere about what is ostensibly the same field known as “economics”.

– the whole system thus laid out always seems to be incredibly fragile and just one step away from utter disaster

– if commenting is allowed, so many divergent or conflicting assertions get made that the end result seems to be to completely befuddle or invalidate the original message, resulting in (at best) a sort of polite shouting match where everyone has their own particular viewpoints and nobody has any idea which (if any) of them are right, nor whether there is any way to reconcile them into some sort of coherent whole.

I’ve felt this way since college – when I may have glanced at a course catalog and read through the various subjects being offered. In all other fields – even things like civil engineering or dentistry or comparative religion or ethnomusicology or world literature – it seems that we indeed do know a few things, or at least like a few things, so there is indeed something worth studying and appreciating there – either because the theories are practical (they get something done) or because the practice is beautiful (it produces something we like).

But both the theory and practice of economics seem to be an utter mess. Nobody seems to have any idea which theory is “right”, and the practice (long-term) seems to always end up leaving our world in a shambles.

Since I regard myself as a fairly intelligent person, my usual reaction when I can’t manage to understand a topic is not to think there’s something wrong with me, but to think there’s something wrong with the topic itself.

So that’s all I really want to say here. If a person who is supposedly an economist can’t manage to make a blog post about a topic as simple as “profits” without the whole thing melting down into yet another free-for-all of conflict and confusion then… well… all I can say is… there really is no “there” there.

If humankind ever were to figure out a way to establish some sort of economic system which actually worked right, I suspect this would require throwing out 99% of what passes for “economics” today.

I appreciate the time and effort Mr. Pilkington has taken to try to explain this simple topic of “profits” – but I just wish I could come away from it feeling more informed rather than more confused.

Seriously though. I find understanding economics is mainly about practice. The problem is that you’re dealing with concepts that are of the highest abstraction but which, paradoxically, have a very real existence — for instance: government spending or aggregate demand. After a bit of practice, these things become second nature. It’s weird. Like having your brain colonised by strange abstract ideas.

Oh, and on the topic of who is ‘right’ in economics… well… me, of course!

(More seriously, you see a lot of conflict over ideology rather than theory — with the latter causing certain people to avoid certain manifestations of the former. So, if people don’t like big government they integrate this into their theories. Or if they hate capitalism with an unbridled passion they integrate this into their theories. I think the post-Keynesians are the most accurate and operate under the least silly presuppositions — it’s also pretty ideologically neutral [at least I think so]. Have a look at Steve Keen’s ‘Debunking Economics’. In one of the chapters he lays this argument out well.)

Thanks. I will have to do some googling to learn more about what the “post-Keynesian” school stands for. From what I’ve been able to gather so far, “Keynesian” tends to mean “it’s ok for the government to run deficits in times of recession”, correct?

I will also look for that book by Steve Keen.

The only “economist” I’ve every been able to actually understand is Antal Fekete, in particular his writings about the Real Bills Doctrine – so maybe right there I’ve revealed myself as an Austrian or something (I still have a hard time remembering which school is which within economics). I have no idea if he’s respected by other economists, and maybe he oversimplified or was swayed by ideology as well – but his writing was the only stuff that I could ever actually understand. (But I am of course duly horrified by Ayn Rand, and I think that Ron Paul, like nearly all latter-day Republicans, is a well-meaning nutjob.)

I should also disclose that I did buy some bitcoins, as I like the ideas of p2p / decentralization (which seems to have worked well for things like file-sharing) and encryption. Again, this may be revealing a particular ideological bent of my own here as well.

That being said, I don’t really feel that the combination of abstractness and realness is an excuse for a field to be so confused. Medicine manages to cure much of what ails us and architecture manages to keep a roof over most people’s heads – very real-life applications which also can require learning some rather abstract concepts as well. I look forward to the day when economics is able to do the same.

As a person with a somewhat mathematical bent, it seems to me that the main questions lurking in most economic systems are: How is money created? By whom? Who gets to get their hands on it first? At what interest rate (if any)?

It seems that we just recently witness the “creation” of anywhere from 14 to 21 trillion dollars since August 2007 or November 2008 (when the current regime really started showing its cracks). The real question here seems to be: who got this money?

It seems that the question of where money and love come from, and where they go, are the two biggest enduring mysteries in the world.

Yeah, Fekete is Austrian School. Regarding what you just said, I just got this in an email from someone who specialises in Austrian School theory (but rejects it). It says a lot:

“The Austrians have many Robinson Crusoe and baker and candle stick maker tales they tell. They seem to hold a lot of sway, especially with people new to these questions. There assumptions are hidden and horribly unrealistic, but nobody sees this unless you call them on it.”

I think that’s pretty on the money.

As for the confusion. I really think it has to do with politics rather than anything else. (And yes, Keynesians think that deficits should be run in recessions — I think they should be run all the time, but hey…).

Many of the questions you asked are the central questions that MMT answers. I’d suggest checking out Randy Wray’s introduction which is running on the NEP blog. It’s very high quality; it’s free and it’s updated every week. He’ll answer some of those questions you’ve asked — and he’s a very clear writer and takes his time with this stuff:

Thank you for these pointers on MMT. I had heard Ed Harrison talking about MMT a few times, as well as many other mentions on this blog. It sounds like an interesting approach and I will start reading up on it.

ScottA: As Philip says, the answers to these and other questions are revealed in the episodes of the cliffhanging serial at NEP.

I suspect this would require throwing out 99% of what passes for “economics” today. Quite right. The last 30-40 years are the worst. More than 99% is truly moronic sh*t dressed up in pseudomathematics. As a Math Guy myself, a rule of thumb is the more wordy an economist is, the more he thinks like a mathematician. The more symbols & equations, the more likely it is fraud. Although I just betrayed my mathiness to someone by explaining that his beliefs equate to the idea that all infinite series diverge.
Another, even better rule of thumb is that the accepted modern mainstream idea is always 100% wrong, the opposite of what is true and makes sense.

MMT probably does not underscore enough how old the theory is, how it is just taking what was common knowledge, mainstream before the 70s, and (re)cleaning it up. The utter mess we all see is there because it is very good at confusing people and making the rich richer & the poor poorer. Though I know that MMT & allied sects that like to call themselves different names are correct, I think the exposition is pretty bad, badly organized, and makes things more complicated than they really are. (Pssst, partly because economists [especially mathematical economists] know no modern (clean, simple) mathematics.)

It seems that the question of where money and love come from … Very, very good! Comparing money to love is on the right track. Everything is clarified once you realize what money is.

I have degrees in Geology and Engineering and thought I was the only one who just could not economics. I tried to study towards barely passing economics and could not manage to pass accounting (it’s written in alien/alchemy language I concluded).

Not true. While investment creates the possibility of a profit. If you build it and they don’t come, you can’t profit.

And banks are very profitable, and they’re just middlemen, service providers.

I think Karl Polanyi had it right: it is the creation and exchange of fictitious commodities that create profits. Polanyi’s fictitious commodities were labor, land and money. To those I’d add bonds, equities and derivatives. All of these fictitious commodities are inherently mispriced, allowing those who control their exchange to skim profits off the top. Labor is mispriced to the low side. Land, bonds, equities and derivatives are mispriced to the high side. Money floats and can be mispriced up or down at will.

Look at the piece again. Investment must be logically prior to consumption. Because people cannot consume without being employed. And people cannot be employed without somebody investing.

Your logic is impeccable, but your conclusion is only valid if we accept your underlying assumptions, which I don’t. You yourself admit that your model is greatly simplified (i.e., not valid).

Like it or not, human beings lived before capitalism, i.e., they consumed without being employed and without somebody else investing. Because MMTers start from the capitalist system, they perpetuate a lot of its flawed assumptions because they are blind to them.

Once the neoliberal economists (who are really running the show; tilting at neoclassical economists is like tilting at windmills; they no longer exist) realize that MMT explicitly builds modern finance into its models, they will embrace MMT whole-heartedly. MMT is going to replace the Chicago School monetarism as the orthodoxy and will be used to advance the same ends. You just don’t realize it yet.

Investment must be logically prior to consumption. Because people cannot consume without being employed. And people cannot be employed without somebody investing.

This is deranged in the exact same way as Biblical fundamentalism which literally believes the earth was created 6000 years ago, but to a far greater extent.

After all, your fundamentalism postulates a much more recent Creation date.

In spite of your lies, humanity not only existed but flourished without “investment”, “consumption” (in your sense of the term, a passive unproductive “consumer”), or “employment” for the vast majority of our natural history. And we can and shall so flourish again, once your horrific interlude is ended.

You’re simply equivocating on the word “profit”. What, exactly, is a “macroeconomic profit”? Don’t tell us where it’s from before telling us what it is.

On this magical world, is there such a thing as “a loss”? If so, where does a loss come from? In this entire post, not a single word about the flip-side of a profit. It’s as if you’re trying to discuss “hot”, without any notion of “cold”.

It is amusing, though….

You imagine this Isle of Lilliput with it’s one government, one capitalist, one factory, one bank and 10 workers.

It’s a Magic Island—that does not interact with other islands, that does not need raw materials, that uses perpetual machinery that never wears down…an island with inhabitants that are Jesus Christ Bread Savants capable of conjuring giant loaves from their thoughts….it’s an island that, in essence, faces no risks whatsoever.

Yet, you take lessons, that according to you, “transfer rather well to the real world”.

And towards the end of this, you actually state the following:

“…Austrians…are utopians. They tend to view the world in terms of how they imagine it could be, rather than as it is.”

Poor Duncan’s comments are getting cruder by the day. Hey Dan, why don’t you ever respond when your comments are shown to be silly, childish and ill-informed.

(For those of you who want to see a prime example look for the last cross-post from Washington’s Blog the other day.)

Poor, poor Dan. He doesn’t even read the things he’s criticising anymore — his head has inflated so much. Look:

Dan: “On this magical world, is there such a thing as “a loss”? If so, where does a loss come from? In this entire post, not a single word about the flip-side of a profit. It’s as if you’re trying to discuss “hot”, without any notion of “cold”.”

Original piece: “When the capitalist laid off his five builders after they had completed his bread factory they lost all their spending power. If they had continued to go unemployed the capitalist would have taken large losses, as he would have only had five rather than ten workers to sell his bread to. He would, in short, have incurred a rather substantial loss. If this had occurred we might predict that the capitalist would have gone bankrupt as his capital was slowly drained away through interest payments and so would not have engaged in future investment.”

No, Dan has stopped even reading the pieces. He just rants. And then when he’s called on his blatant lies and misconstruals he hides like a silly child.

You specifically stated: There is a Microeconomist Inside All Our Heads: He Must Be Destroyed

And then, in response to my statement that you didn’t address MACROeconomic losses, you write:

“When the capitalist laid off his five builders after they had completed his bread factory they lost all their spending power. If they had continued to go unemployed the capitalist would have taken large losses, as he would have only had five rather than ten workers to sell his bread to. He would, in short, have incurred a rather substantial loss. If this had occurred we might predict that the capitalist would have gone bankrupt as his capital was slowly drained away through interest payments and so would not have engaged in future investment.”

Pilky, you’re writing as if you have a microeconomist in your head. C’mon…how is what you wrote a macro-economic response?

You’re essentially telling us to think “macro-economically”, but you don’t even know what it means.

The basis for the entire post is that Macro-economic profits are “different” than micro-economic profits.

It’s such a joke. You’re equivocating. You’re going back and forth, using words and concepts–that you don’t understand–interchangeably.

So…Pilky, one more time—and seriously, if you give a credible answer, I’ll never bother you again:

What is a MACROeconomic profit? And, what is a MACROeconomic loss?

I think they are nonsensical questions. I don’t think you can give an answer. And if you can’t, then your entire post is a joke.

The above example is a ‘macroeconomic loss’ as you call it. The real term for that is ‘deflation’, but let’s not go too far too fast.

You’re in over your head — as usual. And you’re making a fool of yourself — again, as usual. Just stop. It’s embarrassing. You don’t even read the pieces anymore. You just scan them and pull a quote and then try to sound clever.

But you’re not clever. Because clever people don’t troll. Only losers who watch too much porn and can’t dress themselves troll.

You are not merely implying equality, you are explicitly stating equality.

It’s as if you are stating 2x=y.

It’s not the same thing, but you’re too stupid to realize it.

Your equation has one-sided causality. An equals sign is not appropriate here. It’s a pretty important distinction, Pilky.

In your equation, the right side of the “=” sign causes the left side. The left side does not cause the right side except in a recursive sense, in which case your simple equation–frozen in time–is, once again, not appropriate.

It doesn’t mean they are necessarily unequal, but the quality of the equality is not the same as your typical arithmetic equation.

In 2x = y, directionality does not matter. Y can cause 2x, and 2x can cause y.

But that’s not the situation in your profits equation. There’s a directionality to this “analysis” that you’re not getting.

So…for all you dorks massaging this stupid equation, I have some advice—straight outta Troll Land:

There is no macroeconomic profit or loss in a closed economy. Globalization broke this assumption.
Another development is synthetic financial instruments (e.g., ETF tracking SP via futures), which do not return invested capital into the economy.

The problem is deflation in housing prices. As long as housing prices continue to deflate, investment in real estate is dead. It’s like somehow we’re going to spend all this money so that the housing values are re-inflated with purchases from government employees. The problem is that private sector business still have to compete against wages overseas so wages will stay low. Even with vast government spending, there still won’t be any private sector wages to buy all these $400K houses. The value of a house is based on personal income, and income in manufacturing is really at least partially determined by how much guys in China are willing to be paid. Everything that tries to avoid this just causes more depression.

I guess this makes me an Austrian, but I think the housing pries have got to find their bottom. Get all this stuff on the market, and just let the bottom happen. If there are no buyers, homestead act the places. This will screw up local government dependent on real estate taxes, but oh well, they’ll figure out something. At least with low real estate prices, then even if you make 30K a year or something, you might pick up a $100K house. The whole thing starts to work again.

Profits come from the successful theft of the labor time and skill extracted from the workers over and above that which he/she must be paid to keep them alive.

The owner of the capital (machines and factory) then uses a part for personal consumption and material expenses, while re-investing the balance of his loot in new, hopefully more efficient machinery in order to compete with other companies in a similar line of business.

The capital is the embodiment of dead, previously stolen labor. The margin of profit depends on getting materials at the lowest price possible (colonialism has always helped here) while paying his workers the least wages possible to kept them alive. Wages are lowest when there is a huge number of unemployed workers competing for jobs.

The capitalist who steals the most labor successfully wins. Efficient machines help, but they have a fixed cost and fixed life of service. It is not possible to endless extract unpaid for labor from a machine, only from human beings.

Time to abolish the capitalist economic system as it is based on stealing from the many to give to the few. A new economic system has to be created which is not based on theft to make generate corporate profits, but cooperatively produces useful things which human beings need and which allows for the full social and intellectual development of each member of society.

Capitalism is merely a moment in historic development, a stage of history that is no longer necessary or constructive. We can do much better.

A new economic system has to be created which is not based on theft … Justina

Agreed! But that is precisely what our money system is based on – theft. So-called “credit” creation is actually the theft of purchasing power from all money holders including and especially the poor for the sake of banks and business.

Consider a professional sports team. The “labor” are generally multi-millionaires pursuing activities they enjoy. The “capitalists” may be egregiously narcissistic dandies but one can’t say the labor is abused. The capitalist provides labor with a service, in this case. A field upon which to pursue their art.

Consider also a hypothetical well-run enterprise, where the employees are paid well, work collegially together, and take a craftsman’s pride in their work. These places do exist.

Consider an apple orchard owned by a family. Money truly does grow on trees. Or a winery, where money grows on vines. Or a hog farm, where money grows from pigs reproducing themselves through time, propogating through time the Platonic archetype of The Pig. Strange to think of a stream of pigs like a hologram through time.

Or consider a commerical novelist (there are very few, admittedly), where money grows from Imagination.

Money grows from Nature, Labor and Imagination and takes its value when social structures exist that channel (no pun intended) the free flow of Imagination acting upon Nature through the agency of Labor to produce Services & Things that satisfy physical or pyschological human needs.

Money is the abstraction of the energies of social cooperation. And profit is accumulated cooperation held in a state of potential, taking its value from the value of the storage medium. Consider that the primary quality of money is that it calls forth cooperation, if you view the world as a bunch of people moving around in silence, going here and going there, like ants, without language or philosophy, only instinct and desire.

The model is clear on the small scale that you describe. It is the interaction of complex systems, especially the derivatives of real production, and the derivatives of these derivatives that doom present day capitalism; then more bank debt is created to help the gamblers offset their losses. This seems to have made the system gamed for the gamblers, while the middle class gets gamed. A derivative of real production is not real production, and the worker loses his productive value through unemployment. Excess derivatives of real work, offerring nothing but debt liquidity, forces more of the same for sustainability until it explodes.

Nothing is created or destroyed but only changes form. Profit is when net value is positive after the subtraction of cost of creating value. Creating is change. Capitalist are opportunist who can position itself to profit from difference in values, either that is change in difference created by the capitalist himself or just placing your bucket at the right place to catch what is falling. Bankers are the bucket placing types of people who profit from expansion of economy, the changes in value created by the expansion, exactly the positive interest rates. International entrepreneurs mostly arbitrage in difference in the two economies, the changes they profit from. The manufacturers use low waged people to create value by keeping the wages low, it is a form of slavery. In essence buy low sell high, then someone has to lose for you to win. Zero sum. Capitalist economy that prints ever increasing money supply wins, but who loses? the environment, we destroy the planet by excessive demand of material goods. Consumption of Raw materials and garbage it produces. We also kill the indigenous people around the globe who come in contact with capitalists.

Well, in relation to the above presentation we draw a pretty specific conclusion: all profit/money is debt. To quote the famous testimony given by the great central banker Marriner Eccles:

“Chairman of the Federal Reserve Board, Marriner Eccles testified before the House Banking and Currency Committee September 30, 1941. He was asked by Congressman Patman, “Mr. Eccles, how did you get the money to buy those two billions of government securities?” Eccles replied, “We created it.”

Patman asked, “out of what?” Eccles answered, “out of the right to issue credit-money.” Patman then asked, “And there is nothing behind it, is there, except our government’s credit?” Eccles responded, “That is what our money system is. If there were no debts in our money system, there wouldn’t be any money.””

koonyeow’s suggestion:

Anyone interested can actually Google for ‘Modern Money Mechanics’, download the booklet and read it. The organization that published that booklet is quite a surprise.

Consider a model where the capitalist is an equity owner in his enterprise, and whose after tax income is derived exclusively from profit on that enterprise. The capitalist earns income in the form of profit, some of which he retains in his enterprise as saving (retained earnings), and some of which he spends on consumption (e.g. using a dividend to buy a big screen TV).

“Autonomous injections” such as appear in Keynesian economics, such as I, G, and X, are all supportive of aggregate demand and capitalists’ profits. And, as you say, this is consistent with MMT sectoral balances approach.

Clean up point: as I noted earlier, GDP includes gross investment, which includes deprecation, which I think of as “capital consumption”. I was confusing capital consumption with Kalecki “capitalists’ consumption”, partly because the Kalecki meaning and application is old fashioned in terms of institutional structures for saving and investment.

‘Profit” denoting “business profits” is an undue limit on the concept.

“Profit” by a definition not so limited, means an ” increase in well-being: like “profiting” by exercise, or “profiting” from attention paid, or simple thought applied, or from meditation, or from rest, or by doing acts of beneficence and generosity.

Thus it makes sense to ask: “What does it profit a man, if he gains the world, yet loses his soul?”

For ‘profit” is a question of utility: what good does an activity do for you and/or others?

Thus at bottom, “profit” IS identical to virtue: hence the confusion of morality, with economics.

Particularly when one is so blind, as to never see ( or even think to look!) beyond the money – which does seem to serve as the only visible marker of “profit” to the morally blind.

For some “profitable” businesses are, on the contrary, quite useless, and in fact harmful to all – save those who reap that so-called “profit”.

It is not only the money which counts when profit is to be determined.

I often seems to me as if many wealthy (and many poor as well) tend to forget that.

I suppose my point is that “business profits”, which by definition are surplus cash only, are not the only profits to be considered – even in the consideration of business affairs.

Pilkington is an economic ignoramus, and his offering is a measure of the economic ignorance of those who palm off his twaddle and celebrate it on this website. Pilkington is described as a “journalist and writer”; thus his scholarly economic qualifications, which are zero. Some of his fruits: (1)He pretends to announce the origin of profits, but he begins without defining “profits.” Presumably if his next journalistic assignment were cancer research, he’d pursue its origin without defining what, exactly, is the phenomenon under review. Perhaps he’d discover that government causes cancer, just as it causes profits . . . .(2) In his model, wages are declared the sole determinants of price. A broader edition of this false and indeed preposterous notion was briefly mooted by Adam Smith (google “trinity formula”) but was subsequently discredited–as indeed Pilkington himself discredits it, when he begins with an unaccountable interest rate for the banker; while interest rate (in the real world) is the “price” of the banker’s services, but is irreducible to “wages.” What, indeed, Mr. Pilkington is the GDP of your model economy, with or without your accounting of the bakery? (3) No accounting whatsoever of the banker’s income (“wages”?!) is attempted; nor are the “wages” of the presidents accounted for (after all, this is supposed to be a macroeconomic model). So much for consistency. (4) The banker buys the IOU of the capitalist, and gets his principal plus 10% interest in return. Here, Mr. Pilkington, is money begetting money–self-expanding value–the closest your fairy tale ever gets to the real nature of capitalism; to which you are entirely oblivious. (5) Pilkington’s capitalist is a philanthropist: In his first round of production he not only lives on air but receives no profit; a situation of which he presumably knew in advance–yet Pilkington assures us that it is the “expectation” of profit that drives capitalism. (6) But no, Pilkington’s capitalist is a beggar: He makes no profit until government hires the unemployed. So it is government that is the philanthropist; which is the entire ideological point of Pilkington’s twaddle. (He is what is in common parlance called a “liberal” or “progressive”; in scientific parlance, he is a bourgeois reformist.) Here his ignorance of history is likewise on display: If government “investment” creates profits, whatever happened to the USSR, Zimbabwe, the Weimar Republic, etc., where there was a plethora of such “investment”? (7) The costs of capital (the bakery) do (as wages) and do not (as means of production) enter into the price of bread. Wonderful logic, again. The bakery does not (Pilkington para 16) and does (para 27, “capital assets”) enter into the sales of the capitalist. (8) If he’d done his reading, Pilkington would convey why neoclassical economists have no explanation of profit, namely, their role as apologists for the capitalist system: For them there is no such thing as profit in the something-for-nothing sense that any unbiased observer can verify regarding the behavior of any capitalist (or capitalist banker), only justified rewards to “factors of production.” (Google “Samuelson economic profits business profits difference”; “Leon Walras no-profit condition”; “modern capital theory”; “Cambridge Capital Controvery.) (Ever wonder why the apologists for capitalism in the financial media speak of profits as “earnings” of capitalists and wages as mere “costs”?) (10) The invocation of Kalecki is again uniformed: Kalecki’s formula is a general equilibrium condition (which assumes that the macroeconomy is always in equilibrium); while Kalecki assumes that the profit share in the economy is constant unless altered by an exogenous “degree of monopoly”. In a word, Kalecki’s model is as unrealistic as Pilkington’s; and, like Pilkington’s, assumes the existence of what Pilkington says it explains (namely, profit). (11) Neither Pilkington nor neoclassical economics offers a coherent theory of value (the neoclassicals gave up on “utility” a long time ago); or money (which is valuable for Pilkington as long as the president says so; and as long as he’s not the president of Zimbabwe). Yet both founts of wisdom begin with value, money, private property. interest, wages, profit, and price as self-evident terms that “we” already know completely. Irony: Pilkington’s article is so ludicrous that I am entertaining the hypothesis that it was a conscious joke perpetrated to expose the economic ignorance of his readers. (A few years ago, one wag composed an incoherent screed in the “post-modern-studies” fashion, and got it published in a prominent post-modern journal; to the embarrassment of the latter and the laughter of the reality-based citizenry.) Fess up Pilkington, are you putting us on?

“This ties into the MMT argument that government should offset workers’ desired savings.”

This argues for permanent bank nationalization.

Consider a “post office bank”. Workers’ savings go into it, and the government knows exactly how much workers are saving. It can then promptly spend that much. Workers withdraw from it, and the government can cut spending.

This is your best article yet. I could not stand the others, but it really looks like your team is getting their ducks in a row and mounting an offensive.

We’re now at the basics of who is “we” and who is the “government” and the like. Thank god Bastiat is still out there.

Now that we’re playing for real, my only complaint is why did I spend a semester learning about sole proprietorship, oligopolies, monopolies, dead weight and all the rest if profit was not included in textbooks? Marginal revenue, marginal cost, average cost per unit, … Neo-classical education definitely includes profit theory. I know you say there’s more to come, but to say economics does not cover profit is like saying you must only sign up for Macro 302 and not Micro 301 and if you take Micro 301 you have a small brain and profit should only be covered in Macro 302 because the other semester is a waste. There’s more than one textbook and college course. That intro is just wrong at some level.

That’s all I got except for if the five unemployed were strippers and the the capitalist paid them to dance, thank god those wages would come back to capitalist and get reinvested in the economy.

Awesome post! There is very little I have found written on the internet written about the profits equation, but it seems to me like such an important piece of the MMT puzzle. I am very much looking forward to the rest of the series.

I struggled to read this article and all the comments. Has Mr. Pilkington or anyone else ever said what “profit” even is? Has he or anyone given a basic definition of “profit” at the whole-system level of whatever system he or the commenters think they are describing?

What is “profit”? What is “value”? What puts the “value” in “money”? What puts the “alue” in value? What puts the “ofit” in profit? Can anyone tell me without hiding behind a chaff-cloud of economystic obscurantist numbers and equations?

I’m going to take a stab at this. The concept of profit is hard to understand once one steps away from usage in an abstract academic setting.

Profit is what a person or an organism needs to grow in wealth, influence, and even fitness. It’s not just surviving, which is what substience, or breaking even would be. Profit is intake-minus expense. The easiest way, I think to express the concept of profit is to explain it in terms of energy.

If five million calories are used to obtain five hundred million, six thousand calories, that food creating operation was not very profitable, but it was not a net loss.

In a wider context, “profit” is what makes all biological activities worthwhile. If an organism expends more resource than it gains, it begins to starve.

The goal of profit in the human economy as well as the natural economy (the rest of life on Earth) is to get most out of the environment, with minimal expenses.

I’m going to take a stab at this. The concept of profit is not hard to understand once one steps away from usage in an abstract academic setting.

Profit is what a person or an organism needs to grow in wealth, influence, and even fitness. It’s not just surviving, which is what substience, or breaking even would be. Profit is intake-minus expense. The easiest way, I think to express the concept of profit is to explain it in terms of energy.

If five million calories are used to obtain five hundred million, six thousand calories, that food creating operation was not very profitable, but it was not a net loss.

In a wider context, “profit” is what makes all biological activities worthwhile. If an organism expends more resource than it gains, it begins to starve.

The goal of profit in the human economy as well as the natural economy (the rest of life on Earth) is to get most out of the environment, with minimal expenses.

Now we are getting somewhere. Are there any economists or economic journalists who try thinking about these things at the bio-physical reality level? If there are, are they thinking about “economic analysis” within the natural laws and constraints of the bio-physical ecosystem? And . . . what are their names?

If there are not, we are going to have to think about this ourselves, because survival takes place in the real ecosystem.

Environmental economists are out there but seem to be non-mainstream because they promote unpopular ideas . The idea of burning fossil fuels as something bad is not a message someone wants to hear if they’re an SUV driving American or someone who’s just managed to climb out of poverty. Economics is ideologically loaded. Just about all prominant economists subscribe to modernism. One of the cheif tenets of modernism is that science, in the form of energy hungry technology , will solve all human problems. It’s understandable why so many of the world’s elite would cling to this belief. Their wealth is only made possible by the industrial revolution. As an extension of their belief in technology, is the Modern belief that the city is the ideal form of human organization. According to what I’ve gleaned off the latest Popular Science, a number of people professional class believe that crowding people into cities will solve most of the world’s pressing problems and that the mere crowding of the world’s population means that more ‘wealth” (possibly in the form of “falling labor costs”, which is really awful if you aren’t at the apex of society) will be created in the future, despite the fact that those who enjoy a decent standard of living, the various middle classes throughout the world, are a minority. This point of view seems inappropriate for at a time in world history where employment is declining due to innovation and the environmental damage and depletion caused by a century’s worth of progress is starting to rear its ugly head.

you touch upon the subject at the end and I agree that MMT, with its focus on govt spending, misses the bigger monetary picture that the banking system, through securitization, effectively sets monetary levels in the economy. In other words, there is no real distinction between the ‘govt’ and ‘private’ from a monetary standpoint with the exception of QE. The MMT focus on public spending is in fact a communist plot to take over our cherished liberties. The exact same dynamics leading to full employment (the stated goal of academic MMT’ers) can in fact be achieved by the private sector’s profit motive, while the numerical returns go up due to asset inflation.

Asset deflation will create the inverse situation, namely that debt deflation does massively depress demand compared to previous levels and the dynamics there can be depressionary. I understand QE1 from Bernanke in that light, i.e. create enough ‘investment’ through forced liquidity, and the dynamics stabilize.

In thinking about your example and the source of profit in the island. For the capitalist, in the second round, he can produce bread for 10 people but only needs to pay 5. From a micro level that is the profit. In your limited example, only 5 is in circulation, 5 saved as profit. In your example the money for the last 5 comes from “deficit spending”. At a macro level: 10 people produce bread for 10 people (5 working on building) and every one eats. On second round, 5 people produce bread for 10. The fact that some work and some not, should be recognized without need for ‘busy work’ but that is another topic. However the microeconomic argument is that ‘profit’ turns up after initial investment, not necessarily with continued investment. Take the software industry, it’s profit margins are very high because the marginal cost of distributing a new copy (bread) is close to nil. Profit understood as “capitalist savings” is in fact money taken out of circulation and you need the government to step in to plug the hole. I wonder if the ‘transition’ to real world is that straightforward honestly. In real world, the capitalist is rarely sitting on cash. only ‘stagnant cash’ takes away from liquidity.

In other words, in the real world that money goes to other products, new investments. As long as you have ‘growth’ with new products etc, you do have a self-sustaining machine. Capitalism and growth are very much inter-twined.

I say this honestly: this was a very interesting article. Congratulations.

But I believe just a teeny weeny modification could underline a difficulty I found in it.

Let’s imagine there is no bank: our entrepreneur is investing her own money. BTW, I believe the same result obtains in your own example by assuming the bank charges a 0% interest rate and each dollar paid is capital amortization, which I suppose should be acceptable from an MMT point of view. The advantage of doing this my way is that it saves us comparing two sets of balance sheets (the bank’s and the entrepreneur’s).

So, it’s Day 0 and the entrepreneur has $10 cash in her assets/equity side and $0 in its liability side.

During Day 1 the entrepreneur paid $10 to the workers ($5 to builders, $5 to bakers); after selling the loaf of bread, she got $10 back, plus a brand new bakery. Note that she paid her workers for the work received: enough for them to eat that day and the bread price was $10/loaf.

So, at the end of Day 1 we have this: $10 cash plus a brand new bakery (asset/equity side) and $0 in its liability side. Her equity is going up. Ye-haw!

Day 2: she already has her bakery, so, smell you later, builders. She paid $5 to the bakers and got $5 back after selling the loaf of bread. 5 hungry builders watch the bakers eating more bread. Today, she generously paid her workers their due and more for the work received (the price of bread fell: from $10 a loaf, to $5). In other words: the REAL wages doubled. No wonder she makes no profit by selling bread!

At the end of Day 2 we have this: $10 cash plus the same bakery (asset/equity side) and $0 in its liability side. Her equity ain’t goin’ up no more. Goddamn!

She isn’t losing money either, and for all she cares, she could keep at it for ever: after all, she got a brand new bakery, didn’t she? The builders, though, are screwed.

The government does nothing (who gives a damn about some builders, anyway?). That’s a quite different outcome, isn’t it?

But why?

In your original example, the entrepreneur is not THE capitalist, but A capitalist (the other capitalist being… surprise! the bank).

And the entrepreneur is going out of business because she is sharing her profits with the bank: this is what the $1 interest payment does. At the end of Day 5 in your example, she already paid $5 in interests, her liquid assets are falling ($5 left in cash), without her liabilities decreasing a single penny. If she throws the towel then, and gives the bank the key to the bakery plus the money left ($5) to pay for her debt, the bank has acquired a brand new bakery for 5 bucks, recovered $5 in cash and pockets interests for $5.

So, she is also a loser; but the bank, which you mostly forget, is doing just fine, thank you very much.

BTW, Michael Hudson has written about this.

And this is the subtle difficulty I mentioned above: the profits the capitalists as a class receive do not come from investment, as you said. In my version of the example (without interests!), the entrepreneur recovered her investment in Day 1 and even paying her workers enough to eat, there was a brand new bakery! And that is profit!

Finally, let me say this: with this I don’t mean that MMT does not work. I share the logic of government intervention in your example and it is perfect. It just means that some ideological misconceptions are not limited to neoclassical economists.